Unionbancal Corp. v. C.I.R.

• Decision Date: 18 September 2002
• Docket Number: No. 00-70764.,00-70764.
• Citation: 305 F.3d 976
• Parties: UNIONBANCAL CORPORATION, f.k.a. Union Bank, Successor in Interest to Standard Chartered Holdings, Inc. and Includable Subsidiaries, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

305 F.3d 976

UNIONBANCAL CORPORATION, f.k.a. Union Bank, Successor in Interest to Standard Chartered Holdings, Inc. and Includable Subsidiaries, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 00-70764.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 4, 2001.

Filed September 18, 2002.

Frederick R. Chilton, Jr., Paolo M. Dau, and Ward S. Connelly (on the brief), Paulo Dau (argued), Fenwick & West LLP, Palo Alto, CA, for the petitioner.

Jonathan S. Cohen and Charles Bricken (on the brief), Charles Bricken (argued), Department of Justice, Tax Division, Washington, DC, for the respondent.

Appeal from a Decision of the Tax Court. Tax Court No. 11364-97.

Before BRUNETTI, KLEINFELD and THOMAS, Circuit Judges.

Opinion by Judge KLEINFELD; Dissent by Judge THOMAS.

KLEINFELD, Circuit Judge.

This is a tax case regarding availability of a loss deduction to a company whose predecessor-in-interest left a "controlled group."¹

FACTS

The facts are undisputed, because the parties stipulated to them before the Tax Court, but the details are complex. Here is a simplified summary. The Appellant, UnionBanCal, is the successor-in-interest of an American bank that once belonged to a group of affiliated British and American companies, considered a "controlled group"² under federal tax law. While a part of this controlled group, the predecessor sold a loan portfolio at a loss to a British company in the group, Standard Chartered Bank. A statute barred the predecessor from deducting its loss at that time, because Standard was a member of the controlled group.³ When the predecessor left the group, the statute still wouldn't let it deduct the loss because Standard still owned the loans and was still in the group; instead, the loss was "deferred."⁴ Standard later sold the loans to a party outside of the group, and at that time, the statute provided that the deferred loss could be restored. But the statute wouldn't let the predecessor take the loss as a deduction, because it had left the controlled group before the loans were sold outside of the group. The Commissioner would have let Standard take the loss as a stepped-up basis in the portfolio, but that didn't do Standard, a British firm, any good, because British tax authorities wouldn't recognize the stepped-up basis. Thus UnionBanCal's predecessor incurred a loss, of sorts, when it was part of the controlled group and sold the loan portfolio to Standard, that has never been reflected in any firm's taxes, but has reduced the basis and thereby increased the taxable gain for Standard. The predecessor's $1.7 million tax deficiency, for which UnionBanCal is responsible, is at issue.

The facts are hard to understand without the legal background. Under 26 U.S.C. § 267(a)(1), "No deduction shall be allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons" in certain relationships.⁵ These relationships include, among others, those between family members,⁶ individuals and the corporations they control,⁷ the grantors or beneficiaries of a trust and its fiduciaries,⁸ and "[t]wo corporations which are members of the same controlled group,"⁹ such as corporations in a parent-subsidiary chain.¹⁰

The statute works like this. Suppose you want to generate a tax loss without a real loss, so you sell to your wife for $80 stock you bought for $100 a share. It won't work. Section 267(a)(1) of the statute won't let you take the $20 per share loss, because of your relationship.¹¹ But fortunately, when your wife sells the stock on the open market after it's risen to $110, she gets to use your $100 basis, not her $80 basis, to calculate her taxable gain. She gets your basis because, although the statute prevents you from taking the sham loss you generated by selling the stock to her, it also says in section 267(d) that her "gain shall be recognized only to the extent that it exceeds so much of such loss as is properly allocable to the property sold or otherwise disposed of by the taxpayer."¹² This limitation on deductions for transfers between related parties protects the fisc against sham transactions and manipulations without economic substance. Not infrequently, though, there are honest and important non-tax reasons for sales between related parties, so it's important to fairness to preserve the pre-sale basis where loss on the sale itself isn't recognized for tax purposes. Otherwise, the statute would be a heads-I-win, tails-you-lose proposition for the IRS: the seller can't take his loss, but the IRS calculates the buyer's gain on resale using the lower basis.

A variant of this scheme applies to "controlled groups," that is, corporations with interlocking ownership as specified by the statute.¹³ Instead of being disallowed under section 267(a)(1), the loss is "deferred" under section 267(f)(2) until one of two conditions pertains: either

(1) "until the property is transferred outside such controlled group and there would be recognition of loss under consolidated return principles"; or

(2) "until such other time as may be prescribed in regulations."¹⁴

Instead of the buyer getting the benefit of the loss as a stepped-up basis, as in the husband-wife example, the seller takes the loss as a deduction, but not until the buyer sells the property outside of the controlled group or until the regulations otherwise provide. UnionBanCal's predecessor-in-interest was a seller in such a "controlled group" when it sold its loan portfolio to Standard at a loss, and UnionBanCal complains that the IRS improperly denied the predecessor's deduction for that loss.

UnionBanCal's predecessor couldn't take the loss because the predecessor left its controlled group before its buyer within the group sold the property to an outsider. In 1984, the year the predecessor made the sale, the Commissioner of Internal Revenue issued a temporary regulation under section 267(f)(2) governing sales between controlled group members.¹⁵ The temporary regulation provided that "[i]f a selling member of property for which loss has been deferred ceases to be a member when the property is still owned by another member, then ... that loss shall never be restored to the selling member."¹⁶

The temporary regulation's "never" limitation still doesn't create a heads-I-win, tails-you-lose situation for the IRS. When, under its provisions, a selling member may "never" take a loss, the regulation falls back on a rule analogous to that in the husband-wife example: the buyer within the controlled group gets to use the seller's higher basis when the buyer resells the property outside of the group. The temporary regulation states: "On the date the selling member ceases to be a member, the owning member's basis in the property shall be increased by the amount of the selling member's unrestored deferred loss at the time it ceased to be a member...."¹⁷ Thus, if UnionBanCal's predecessor-in-interest had bought the property for $100 and sold it to Standard for $80, and then left the controlled group while Standard was still a member, the temporary regulation wouldn't let the predecessor take the $20 loss, but it would let Standard use UnionBanCal's $100 basis, rather than its $80 basis, when it sold the property to an outsider.

In this case, however, because of the international character of the controlled group and the transaction, the temporary regulation really did create a heads-I-win, tails-you-lose situation. UnionBanCal didn't get to take the loss as a deduction because of the temporary regulation's "never" provision. But Standard didn't get to use UnionBanCal's basis, as American law allowed, because British law, which controlled Standard's tax liability, didn't allow it. UnionBanCal argues that this result demonstrates that the temporary regulation is contrary to both the legislative scheme and the British American tax treaty and that it should be allowed to take its predecessor's loss as a deduction.

In 1995, after UnionBanCal's predecessor left the controlled group and after Standard sold the loan portfolio outside of the controlled group, the Commissioner changed the Treasury Department's position in a way that would have let UnionBanCal benefit from its predecessor's loss, had the change been retroactive. The Commissioner replaced the 1984 "temporary" regulation with a final regulation¹⁸ under which, had it been in effect, UnionBanCal's predecessor-in-interest could have taken its loss from its sale to Standard when it left the controlled group, even though Standard hadn't yet sold the loans outside of the controlled group. The final regulation states that a seller's "loss or deduction from an intercompany sale is taken into account under the timing principles of [26 C.F.R. § 1.1502-13], treating the intercompany sale as an intercompany transaction."¹⁹ Under 26 C.F.R. § 1.1502-13(f) (1995),

the deferred ... loss attributable to property ... shall be taken into account by the selling member ... [i]mmediately preceding the time when either the selling member or the member which owns the property ceases to be a member of the group....²⁰

This provision appears to mean that the seller in a controlled group transaction may claim its deferred loss when it leaves the controlled group, even if the buyer has not yet sold the property to an unrelated party²¹ — precisely what the former, temporary regulation prohibited. But this 1995 regulation, the benefit of which UnionBanCal seeks, doesn't apply to transactions that took place before July 12, 1995,²² which means it doesn't apply to UnionBanCal's predecessor's intra-group transaction.

Here, in more detail, are the events giving rise to this litigation:

1984 Union Bank, Appellant UnionBanCal's predecessor-in-interest, was the indirect American subsidiary of a British company, Standard Chartered Bank.²³ Both were members of a controlled group. Union Bank sold a portfolio of loans to foreign...